Cash classification is one of the most consistently underestimated issues in acquisition finance, and the consequences of getting it wrong fall on both sides of the table.
Three Types of Cash: Three Different Outcomes
Not all cash on a target's balance sheet is worth the same to a buyer, or delivers the same value to a seller. Practitioners working on M&A transactions need to distinguish between at least three categories:
- Surplus cash
- Trapped cash
- Operational cash
Each is treated differently in the price mechanics, and confusing them can lead to material value leakage or unexpected disputes at completion.
The distinctions sound straightforward. In practice, they are anything but.
Where it Goes Wrong
For sellers, the risks include leaving surplus cash in the business when it should have been extracted pre-completion, accepting a buyer's characterisation of cash as trapped without adequate pushback, and misunderstanding how the working capital peg interacts with the cash adjustment. Any of these can reduce net proceeds, sometimes materially, without either party fully understanding why.
For buyers, the risks are equally real. Paying for cash that cannot be freely accessed or repatriated. Failing to identify operational cash that must remain in the business to keep it trading. Allowing a drafting mismatch between the working capital definition and the cash adjustment creates a double-count that inflates the purchase price. These are not theoretical risks. They arise regularly, and they are often not identified until the completion of the accounts process is underway.
Why is it Consistently Overlooked?
Part of the reason is that cash issues sit at the intersection of legal drafting, accounting and commercial negotiation. The financial adviser may focus on the working capital peg without fully considering the cash definition. The lawyer may draft the cash adjustment without cross-checking it against the peg mechanics. Neither may have stress-tested what happens at completion if the actual cash position differs from what was assumed.
The result is that disputes which could have been avoided at the heads of terms or SPA negotiation stage emerge only when it is too late to restructure the mechanism.
What Good Looks Like
Getting cash right in an M&A transaction requires advisers on both sides to ask the right questions early: what cash does the business actually need to operate, what cash is genuinely free, and what restrictions apply to cash held in subsidiaries or regulated entities? The answers should drive both the SPA definitions and the price mechanics, and the two need to be consistent with each other.
These issues are explored in depth on
Redcliffe Training's advanced M&A course, covering the financial, accounting and negotiation dimensions of acquisition agreements.